Profit Maximization and Wealth

Maximization
Financial Management
 Learning outcomes
To understand what is profit maximization
approach.
To understand what is wealth maximization
approach.
To compare both profit maximization and wealth
maximization approaches.
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 Difference B/W Profit Maximization and
Wealth Maximization
The essential difference between the
maximization of profits and the maximization of
wealth is that the profits focus is on short-term
earnings,

while the wealth focus is on increasing the

overall value of the business entity over time.
 Difference B/W Profit Maximization and
Wealth Maximization
• Planning duration. Under profit maximization,
the immediate increase of profits is paramount,
so management may elect not to pay for
discretionary expenses, such as advertising,
research, and maintenance.
• Under wealth maximization, management
always pays for these discretionary
expenditures.
 Difference B/W Profit Maximization and
Wealth Maximization
• Risk management. Under profit maximization,
management minimizes expenditures, so it is
less likely to pay for hedges that could reduce
the organization's risk profile.
• A wealth-focused company would work on
risk mitigation, so its risk of loss is reduced.
 Difference B/W Profit Maximization and
Wealth Maximization
Pricing strategy. When management wants to
maximize profits, it prices products as high as
possible in order to increase margins.
A wealth-oriented company could do the reverse,
electing to reduce prices in order to build
market share over the long term.
 Difference B/W Profit Maximization and
Wealth Maximization
Capacity planning. A profit-oriented business
will spend just enough on its productive capacity
to handle the existing sales level and perhaps the
short-term sales forecast.
A wealth-oriented business will spend more
heavily on capacity in order to meet its long-
term sales projections
 Difference B/W Profit Maximization and
Wealth Maximization
Profit maximization is a strictly short-term
approach to managing a business, which could
be damaging over the long term.

Wealth maximization focuses attention on the

long term, requiring a larger investment and
lower short-term profits, but with a long-term
payoff that increases the value of the business.